John Locke has a margin account and deposits $50,000. assuming the prevailing margin requirement is 40 percent, commissions are ignored, and the Mix-Up Corporation is selling at $35 per share.
a. How many shares can Mr. Locke purchase using the maximum allowable margin?
b. What is Mr. Locke's profit or loss if the price of Mix-Up's stock:
i. Rises to $45?
ii. Falls to $25?
c. If the maintenance margin is 30 percent, to what price can Mix-Up Corporation's stock fall before Mr. Locke will
receive a margin call?
The margin is 40% and Mr. Locke currently has $50,000 on deposit in his margin account. If Mr. Locke uses the maximum allowable margin his $50,000 deposit must represent 40% of his total investment.
Therefore, $50,000 = 0.40x or x = $50,000/0.40 = $125,000
This sum represents $50,000 of Mr. Locke's equity and $75,000 of borrowed funds. Since ...
The solution demonstrates how to calculate the number of shares that a buyer can purchase given a particular margin requirement. It also explores the level of profit or loss that the buyer will incur if the stock price changes and finally it demonstrates how to calculate the lowest price that a stock can fall to, given a particular margin maintenance level, before a margin call is issued.